Tuesday, June 28, 2011

Helping Charles Li find the weeds in his Hong Kong garden

Charles Li, the CEO of the Hong Kong stock exchange, has been on CNBC and again at home telling the world that the scandals happening with Chinese stocks on the American stock exchanges won't happen in Hong Kong.

Compared to the Reverse Mergers on the American Stock exchanges the Hong Kong exchange is indeed a beautiful garden with many flowers and some fruit trees.

But there are some weeds there - indeed many weeds there. Some have grown so high they are strangling the light.

And a diligent gardener does not ignore the weeds lest they starve the flowers and fruit-bearing plants.

So I hope to help Charles Li a little. He is blinded by the bright and beautiful flowers of China that litter his garden (ahem exchange). He can't see the weeds no matter how tall, how prominent.

Somebody has to help him so he can continue to tend his garden and so that it might continue to flower into the future.

So I am going to focus a little on Hong Kong in the future: a service to Mr Charles Li and thus a service to Hong Kong.

But hey - I figure there are far more weeds in Hong Kong than the ones I have found (though these weeds are very tall - they almost grow to the sky).

If readers want to help me find the weeds in Mr Li's garden please contact me through the blog.

Apropos to this new theme on John's blog, what would others recommend as the short list of Hong Kong business publications to subscribe to, in order to get good (preferably skeptical) coverage of individual issues on the Hong Kong market?

To be fair to Charles Li, his actual claims are fairly benign. He says that Hong Kong is "less likely" to be fooled by Chinese frauds. He never stated flatly that Hong Kong would not be fooled.

That sets a very low bar to jump over, because in the US nearly *all* the Chinese RTOs look to be either fraudulent or highly misrepresented opportunities. If 60% in US are fraud, and only 20% in Hong Kong are fraud, then strictly speaking Li is meeting his claim.

Said differently, the regulatory failure in the US is so enormous that almost any level of real regulation is likely to look better on comparison.

To the extent that Hong Kong has *any* regulatory process that is effective in blocking even 1/2 of the potential frauds, that is more effective than the SEC, whose lack of regulation apparently allowed nearly all of the frauds to slip through.

John, I wonder about the internet gaming companies and their methods of revenue recognition. The shift in recent years in China towards business models that give away the games for free and then charge users for "in-game" purchases means it has been difficult to corroborate what the companies say are their revenues. These stocks are valued at multiples of US equivalents in some cases.

Zhongwang a couple of years ago hit the newswires as it appeared some of their "sizeable" customers might not have been so sizeable after all (or even, customers). This happened quite soon after the IPO.

Coal companies I also think are problematic. Hidili springs to mind... something dodgy happened (unexplained) to their CFO soon after the IPO.

And the property developers... a minefield there.

As a general comment, I would look at where companies of whatever ilk have pledged their shares- not always a disclosure that is made- Given what I feel is undoubtedly a property bubble and massive Ponzi scheme in China, I suspect most companies are leveraged into real estate at some level or another.

Persistentone-David Webb's site at http://webb-site.com/ has always been good on corp governance issues. Read his latest on Real Gold.. maybe some of you know/remember XING.Caixin (set up by ex-Caijing) which covers macro and financial related issues well, with some decent commentators (Andy Xie writes for them)- http://english.caing.com/Wasn't the Next magazine article from several years ago... maybe even a decade ago, if I recall (unless you refer to a more recent one)... when they went to take pictures of the sites and found one small farm plot behind a washing clothesline ;)- KC

Is there any sort of primer you would recommend to help novices like myself find fraud opportunities. I continue to read your blog and appreciate previous posts that discuss this, but a blog post or book you recommend would be awesome

Have you looked at Sinolink Worldwid Holdings Ltd? It's traded as HK:1168. Its valuation is US$150 million less than its net cash position -- i.e. market cap = US$380 million and net cash = US$530 million. Either its a fraud and the market is discounting it or its a terrifically cheap investment.

john, I'm a huge fan. i love what you do. I love what you do because you seem to me to be a reluctant teller of truth--i get the sense you'd rather there not be fraud in the system...this post sounds a little taunting, coy, and maybe a little mean. i like you much better as the reluctant general doing his duty despite his disdain for bloodshed, as opposed to the bellicose general enthused with war.

just to reiterate, i think you're doing a valuable service--just think that the tone sounds weirdly bellicose.

i think you were trying to comically mimic the kind of weird opaque analogies that come from the chinese about flowers and turtles and tigers and other stuff.

Have you ever cast your eye over China Modern Dairy (1117 HK)? Basically some ex-China Mengniu (2319 HK) employees set up the company in just 2005 and they simply produce raw milk (Aussie Holstein cows with some U.S. input, so to speak). One customer – China Mengniu. Tax-free treatment ‘till c.2018. No real comparatives as most dairies are consolidated with logistic ops. In any event, I’m somewhat dubious of their margins, especially in such a short time. Perhaps I’m underestimating the power of the cow.

KC, I agree with your comment on internet gaming and property developers (I'm not so familiar with coal). However, hard to find concrete evidence. Other dodgy sectors that come to mind are the milk/infant formula, outdoor media, forestry and sports apparel sectors. Issues range from outright fraud to highly aggressive accounting. Actually, if you include aggressive accounting, then the list can potentially be very long...-CT

A good history lesson / precedent is to revisit the S-Chips debacle in Singapore (which John has highlighted before). Most of those Chinese companies that listed in Singapore under lighter touch regulation pretty much ran into difficulties. I would look at the types of industries they operated in; that is a decent starting point to identify HK listed names in similar sectors.

CT- Agree. Extremely hard to prove on the internet / gaming companies as their entire revenue recognition method is so subjective and can be manipulated in a variety of ways. Easier to identify questionab;e property developers however, where at the very least, you can count the empty apartments ;)

Hey John the Clown how is that $SNOFF short working now. Wellington just made a $100 million investment in Sino-Forest. Now should I trust your $100 short or a company with $660 billion under management?

Dear John,Chaoda I would have flagged, but clearly this is a widely known target.However, I would be very interested in what you think of China High Precision (591 HK): 1) super-normal profit margins that do not seem to correlate with comparables (c.f. rotork) 2) possibly low reported staff numbers 3) recent listing vs low capex history 4) very complicated corporate holding company history 5) some other subjective oddities in the formulation of its corporate story and business model which I can go into.I'd have loved to do more work on it, but unfortunately I don't get paid for being short stock.please keep up the great work,EL

If you think having a large AUM means they have better judgement, then you should look at the historical performance that points to how large asset managers under performed the market. If anything, size is the enemy of performance in this business, and numerous high profile asset managers have lost money on frauds (Fidelity on Longtop). The only reason it has not killed their fund is just because they are way too big for it to move the needle.

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.